Webinar for Entrepreneurs: Venture Capital Term Sheets (Plus More)

by Scott Edward Walker on April 15th, 2010


My colleague, Susan Morgan, conducted a webinar yesterday with respect to venture capital term sheets for the “CFO University,” which is group of Chief Financial Officers convening monthly webinars via CFOwise.  As I have previously discussed, Susan recently joined our team and has strong financing experience, including 7+ years at Fenwick & West in Silicon Valley where she closed more than 30 financings.  (You can learn more about Susan’s background on her bio page.)  In conjunction with the webinar, Susan also wrote a brief post on convertible notes.  You can see the webinar and read the post below.  Many thanks, Scott

Webinar: Venture Capital Term Sheets

CFO University:  VC Term Sheet and Deal Point Discussion

Guest Speaker:  Susan Morgan of Walker Corporate Law Group, PLLC

Date:  April 14, 2010, 9:09 am (Denver Time)

Summary:  This webinar runs for about 55 minutes and covers all of the key venture capital terms, including liquidation preferences, dividends, redemption rights, conversion rights and anti-dilution provisions.

Link:  Please click the following link to play the webinar (you can start at the 3:30 mark):

Why I Recommend Convertible Notes for Entrepreneurs by Susan Morgan

The vast majority of startup entrepreneurs obtain their first few morsels of financing from friends and family, founder infusions and/or (with some luck) small, but sophisticated angels.   These infusions may aggregate up to $500,000 or less, and every penny is desperately needed by the entrepreneur to reach the “next stage” of development – which would then allow the entrepreneur to obtain more serious capital from more institutional investors.  At the point in time in which these initial small infusions are made, the company is often unknown, their products undeveloped and their markets unrealized.  What then is the best financing structure for these initial investments?  I would argue that it is convertible promissory notes (or “Bridge Financing”).

The alternative to a Bridge Financing – issuing the first round of preferred stock – requires (i) the valuation of the company for pricing the stock and (ii) the determination and documentation of all of the rights, preferences and privileges of the stock.  How do you price the company at this stage?  Any metric you use can easily produce a number that turns out to be “way off the mark” when the company later completes its development (or whatever progress it has made using the initial funds), and then seeks to obtain subsequent funding.  Accordingly, the founders could be substantially diluted at this early stage.

At the “second funding” stage (the so-called “Series A” round), a larger institutional angel or VC will evaluate the company’s progress and determine a valuation (and price per share) for the more substantial infusion that they are proposing to make.  The rights, preferences and privileges of the preferred stock will also be negotiated at this stage, and the Bridge Financing notes will simply convert to the preferred stock on those terms.  The advantage for the entrepreneur, of course, is that the documentation for the Bridge Financing is far simpler and therefore much cheaper than that of the preferred round.  With a Bridge Financing, the shares will thus be priced much later on when the company has more to show, yielding a potentially higher, more realistic price for the funds infused.

So, what is to induce the early stage investors to invest in the convertible notes?  Typically, they are offered “equity sweeteners” in the form of either (i) conversion at a discount (generally from 10% to 40% discount) or (ii) warrants to purchase shares in the future (preferred or common shares).  These are somewhat equivalent economically, and usually either one or the other is used.

As my colleague Scott Edward Walker discusses in his post on types of angel financing, the disadvantage of issuing convertible notes is that the founders’ interests and the angels’ interests may not be aligned because it’s in the angels’ interest for the Series A valuation to be low.  Indeed, angels who think they can make a significant contribution to a venture (e.g., as a result of their introductions or domain expertise) want to share in the increase in value they are creating.  Accordingly, if angel investors do agree to the issuance of convertible notes, they will often push for a “cap” on the Series A valuation — which is obviously not in the founders’ interest and is heavily negotiated.


This post obviously covers a lot of territory, but hopefully introduces entrepreneurs to some of the key issues with respect to angel and venture capital financings.  If you have any questions, please shoot them to us via the comments section.

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